I never claimed to be brilliant or even smart. But we’ve got a serious problem when it’s suggested that low interest rates cause deflation and high interest rates cause inflation after all these years of consensus that it’s the other way around. How can we have the argument that too low for too long caused the bubble boom existing in the same place and time as the low interest rates cause deflation argument?
Somebody is wrong. Or maybe both are equally wrong. Perhaps interest rates don’t cause anything in and of themselves, or at least cause anything within a reasonable range. Certainly, if the Fed came out and said it would raise the FF rate to 15% tomorrow we’d have some sort of undesirable effect. But runaway inflation being the effect is really hard to imagine. Scaling it down, would scale down the effect. And the reason is, not the rate itself but signaling. I’m sure that a FF rate at 15% is the right rate for some state of equilibrium, it isn’t right for the current equilibrium – and it’s taken quite a while to achieve some sort of equilibrium at 0-0.25% since the 2008 crisis.
Of course rebuttals don’t always have to be elaborate to at least cast some shadow of doubt. So I want to step through the Neo-Fisherite argument to see if it reflects reality. If the natural interest rate is somewhere below zero, say about -2% where it was most of last year, and we’re at the ZLB, if the argument is that setting the FF rate at the rate of natural interest plus the desired inflation rate would produce that inflation rate, where is our 2% inflation? Take the natural rate, in my example -2%, and set the Fed funds rate at the natural rate plus the inflation target, which is 2%, we arrive at a FF rate of zero. And since we’ve been at zero since 2008 – where is the 2% inflation? Logic fail. Not to mention that the BoJ has already cast enough doubt on the theory over the last two years – I did not need to add more.
I don’t mean to be a fly in the ointment of these very brilliant people. But if what is proposed doesn’t match recent examples of reality, they have a steep hill to climb in convincing me that their argument has merit.
And of course I find all of this puzzling because these theories have a certain element of risk involved if taken at face value. If it is straight forward that permanently adding base in an environment of equilibrium has some upward effect on inflation, and the inflation target has been missed so often that it is highly in doubt, one would think that the straightforward thing with the straightforward signal – that the Fed is actually serious about its target- would be tried before playing with things that nobody understands. Perhaps this is one reason why arguments such as this are put forward. They aren’t expected to be tried, with the expectation that the straightforward things won’t be tried either. Never to be proven wrong is better than being completely wrong.
I am sorry. But the financial and economic health of the public is too important to be put it at risk because some intellectuals don’t seem to comprehend the phrase “I was wrong” unless uttered by someone else.